Can Chevron Survive the Weakness?

Chevron (CVX) reported its fourth quarter and full year 2015 earnings results on 29th January. The Upstream business segment of the company reported a loss of $1,361 million for the quarter compared to a profit of $2,673 million for the same quarter a year ago. Chevron reported a loss of $ 1,961 million for full year 2015 compared to a profit of $16,893 million in 2014.

The weak areas

The decline in earnings at the Upstream can be completely attributed to the nearly 50% year-over-year decline in crude oil prices over the one year period.

Chevron management is very aware of the fact that crude oil prices will stay lower for longer than anticipated 2 quarters ago. Hence, in response, it is taking significant action to improve earnings and cash flow in this low price environment.

The actions to be taken at such times are majorly cost cutting and efficient production as far as restricting the operating cash outflow is concerned. On the other hand reducing the capital expenditure related to new projects also helps conserve a lot of liquidity in the company's hands. Then, asset sales also prove handy in generating positive cash flows. Chevron is treading a similar path since its aim at the moment is not growth. It is to save cash and stay in the game.

Chevron CEO John Watson stated the financial implications of these actions in these words, “Operating expenses and capital spending were reduced $9 billion in 2015 from 2014, and I expect similarly large reductions again in 2016. In addition, asset sales proceeds were $6 billion in 2015, with additional sales planned for 2016 and 2017.”

Cash generation is strong

Chevron generated $19.5 billion cash from its operations in 2015. Proceeds from asset sales in 2015 were $5.7 billion, taking the 2 year total to $11 billion. At year-end, balances of cash, cash equivalents, time deposits and marketable securities decreased by $1.9 billion to $11.3 billion compared to year-end 2014.

However, Chevron increased its net debt from $14.7 billion to $ 27.3 billion by borrowing approximately $11 billion. However, at year end, the net debt ratio stood at approximately 15 % and the debt to equity ratio stood at 23 % which leaves enough room for leverage. It also means that the company is advantaged with a considerably low debt load against the operating cash flows that it is generating.

But even with a low debt load, it won’t be very wise of Chevron to pay the dividends that it is actually paying. Its cash flow from operation is not even close to its capital expenditure for the year 2015. And this capital expenditure belongs to a period when the company is not investing in new exploration projects. So even if we add the $5.7 billion proceeds from asset sales to the operating cash flow of $19.5 billion, the capital expenditures of nearly 4 billion was to be covered by raising new debt. Paying high dividends ($8 billion) on top of that doesn’t fall into place from the viewpoint of long-term value creation.

Oil Forecast

Until almost the end of 2015, the global oil production was running out of hands while demand was just ambling. But as the year-end approached, the major oil producers of the world started paying heed to the oversupply in the market. U.S. crude oil production in December fell 80,000 b/d from the November 2015 level and it seems to keep declining for at least the next two years. EIA estimates that global oil inventories increased by about 1.9 million b/d in 2015, marking the second consecutive year of inventory builds. Inventory levels are expected to rise throughout this year and stagnate somewhere in mid-2017 when the demand and supply of crude oil are expected to rebalance again after they got separated from each other back in 2014.

In fact, efforts are underway from not only the non-OPEC nations but also Russia and Saudi Arabia, the largest producers in the world with the latter being an OPEC member. Further, more OPEC members like Venezuela, Iran and Iraq also are in talks with each other on the issue of capping production. Except Iran, all these OPEC countries plus Russia have decided to agree on limiting their production to January levels. But this is contingent on other producers, most notably Iran, taking part. However, Iran has already declared it “illogical” to expect it to freeze production so soon after the international sanctions were lifted. On the other hand, the US crude oil inventories fell by 3.3 million barrels last week to 499.1 million defying expectations of 3.9 million barrels rise to 505.9 million barrels.

Conclusion

The oil prices are expected to stay weak for at least the next two years. The oil inventories are expected to further rise throughout 2016. EIA forecasts suggest that the global demand will most likely match the global supply no sooner than mid-2017. Hence, a sustainable uptrend in prices is at least that far away.

Chevron is doing all it could to cut its capex and opex and the dollars it has saved this way in the last year are appreciable. But it shouldn’t involve itself in financing dividends through debt. That is not a very sustainable way of managing cash flows especially when you are not generating enough to cover the capex.